preliminary understanding of what the whistleblower is saying, we would then create an “issues matrix” that captures all concerns raised and lists the investigative work steps that we would take with the objective of evaluating each allegation and determining whether it has substance. The goal is to validate or refute each item based on the facts and to determine next steps accordingly. We also assess the likely materiality of the allegations and consider whether other aspects of the entity’s financial reporting process could be impacted (even if not directly addressed by the whistleblower). Our workplan would include assisting on tasks that are usually led by counsel, such as interviews and electronic discovery, as well as tasks we would lead on, like forensic accounting work on the books and records and assessment of any potential internal control weaknesses, as applicable. In most cases, the company will have an internal team that can help get the forensic team oriented and gain efficient access to records and relevant personnel. This can be a senior person in the office of the General Counsel or Internal Audit Department or sometimes a senior accounting executive. We would also attend an initial meeting with the external auditors, so they can begin to fulfil their obligations related to the investigative process. In some matters, the company may retain crisis management consultants and/or a public relations firm to handle external communications (if the matter is publicly known). Sometimes we have been asked to help educate the communications team on the details of the accounting issues and associated risks to help them frame their approach. In the context of accounting investigations, what are the typical red flags that might prompt further scrutiny? When evaluating whether there are red flags present, it is important to understand the “normative model” of the company and, to some extent, the typical industry practices. For example, a division of the company may utilize an older general ledger system that requires a lot of manual journal entries to close the books each quarter. Usually, the presence of a lot of manual journal entries is a common red flag as it may suggest inappropriate management override of controls or an attempt to “manage earnings.” On the other hand, if the practice is well known and visible to the company accounting team and external auditors, then it is likely to be worthy of some review but may not be a serious red flag. Industry practices can also be relevant when assessing the likelihood of red flags being present. In some technology sectors, it is common for buyers to wait until near the end of the company fiscal quarter before they seriously negotiate a purchase of software (as they feel they will get a better deal). This can result in many sales being closed in the last few days of the reporting period. This may be a red flag and would require some review and analysis, but given the prevalence in the industry, it may not be a dispositive red flag. The above is not intended to suggest that red flags do not merit scrutiny and analysis, especially if raised by a whistleblower. Rather the goal is to highlight that the context applicable to a potential red flag is very important and needs to be a part of the investigative analysis. Some examples of typical red flags that can arise include: Lack of sufficient internal controls over financial reporting related to revenue recognition – In this example, consider a business that manufactures complex medical equipment (e.g., sonogram machines, MRI machines, etc.) These items have hardware and software components. Often, the sales team will be keen to offer incentives to customers to encourage them to purchase the machine. These incentives can include free software upgrades in the future or other benefits that are not yet fully known or available (but are anticipated). EXPERT INSIGHT 31
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